India’s biggest banks are piling on the losses, and investors are loving it

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The Indian banking sector is in a curious situation: Some of the country’s biggest banks are reporting losses, yet stock markets are rewarding them.

The State Bank of India (SBI), India’s largest lender, reported a 38% decline in its net profit in the July-September quarter of financial year 2018. Given the decline, one would have expected SBI’s share price to fall. However, it rose over 6% on Nov. 10 after the results were announced. Similarly, Bank of Baroda (BOB) reported a 36% fall in net profit on Nov. 14; its stock jumped to Rs174.40 from Rs171.80 a day ago.

What’s fuelling this market exuberance?

The subdued earnings are a result of increased bad loan provisions, signalling that the lenders are seriously cleaning up their books. In all, India’s banking system was saddled with Rs7.29 lakh crore of gross non-performing assets (NPAs)—about 5% of the country’s GDP—at the end of March 2017.

So the markets are ignoring the losses and celebrating the improving asset quality situation instead.

Moreover, the bad loan piles of most public sector lenders have reportedly also reduced a little in the July-September quarter. This includes SBI, Punjab National Bank, BOB, Bank of India, Union Bank, Dena Bank, and Indian Overseas Bank.

The bad loan mess

This decline may be an indication that India’s bad loan crisis may have finally peaked. Still, analysts suggest it may be prudent to wait for another quarter to be sure. “If such a tendency persists in the next two quarters it may be concluded that the recognition issue has been adequately addressed by banks,” domestic rating agency CARE Ratings said in a report.

Indian banks’ share of bad loans, those on which borrowers have stopped repaying either the principal or the interest, had risen over the last three years. Stressed loans (including NPAs), restructured loans, and written-off assets presented a grim picture. At nearly Rs10 lakh crore, these stressed assets account for about 12% of the total loans in the sector.

Now, with the worst behind them, lenders can focus again on growth.

“The results reported by most of the public sector banks look positive as slippages have reduced, and that is a positive trigger,” said Siddharth Purohit, research analyst at SMC Institutional Equities, a domestic brokerage. “But now that most of these bad loans have been accounted for and taken care of, banks will now be able to focus on business and loan growth.”

Also helping the sector is the Narendra Modi government’s bank-recapitalisation plan unveiled in October. It will pump in Rs1.35 lakh crore via recapitalisation bonds subscribed to by banks. With better capital positions and balance sheets, the lenders are expected to raise the remaining Rs76,000 crore from the financial markets.